Employee Benefits

Employee Benefits Developments October 2005

RULINGS, OPINIONS, ETC.

New Guidance on Deferred Compensation. The second round of long-awaited guidance governing nonqualified deferred compensation under § 409A of the Internal Revenue Code (Code) was finally issued on September 29, 2005. Added to the Code by the American Jobs Creation Act in October 2004, § 409A drastically overhauled the rules applying to nonqualified deferred compensation plans and arrangements. Initial guidance was issued by the Treasury Department and the Internal Revenue Service (IRS) late last year in the form of Notice 2005-1, and additional guidance was promised for 2005. Issued as proposed regulations, the lengthy guidance is available at last, and provides some much-needed clarifications of rules covered in the notice, as well as additional guidance on the statutory requirements. Of key interest to plan sponsors is the extension of some (but not all) transition rules until December 31, 2006. The Employee Benefits Group is preparing highlights of the proposed regulations, to be issued shortly in the form of a separate newsletter. Stay tuned.

IRS Ups the Standard Mileage Rate. Reacting to sharp increases in the price of gasoline, the IRS, on September 9, announced a special adjustment to the standard mileage rate for the final four months of 2005. The optional business standard mileage rate has been increased by 8 cents from 40.5 cents per mile to 48.5 cents per mile for business miles driven between September 1, 2005, and December 31, 2005. The IRS also announced that the rate for computing deductible medical or moving expenses has been increased by 7 cents from 15 cents per mile to 22 cents per mile for miles driven between September 1, 2005, and December 31, 2005. Rates for 2006 have not yet been announced. IRS Announcement 2005-71.

PBGC Publishes New Model Participant Notice. The Employee Retirement Income Security Act (ERISA) requires plan administrators of certain underfunded pension plans to notify participants and beneficiaries annually of the plan’s funding status. Generally, the plan administrator of a pension plan for which a variable rate premium is payable for the 2005 plan year is required to issue the 2005 participant notice, unless the plan meets a prescribed funding-related test. Each year, the Pension Benefit Guaranty Corporation (PBGC) updates and republishes a model participant notice to reflect the latest information on the maximum benefits guaranteed by the PBGC. The model 2005 participant notice was published September 14, 2005, as part of PBGC Technical Update 05-1, and can be viewed at www.pbgc.gov/practitioners/law-regulations-informal-guidance/content/tu15012.html.

Form W-2 Reporting Requirements for Grace Period DCAP Expenses. Under the “use it or lose it” rule that applies to flexible spending accounts, an employee forfeits amounts contributed to a dependent care flexible spending account to the extent the employee’s contributions for the year exceed the expenses incurred for the year. To mitigate the harsh consequences of this rule, the IRS said, in Notice 2004-42, excess amounts in a participant’s flexible spending account at year-end (i.e. amounts that otherwise would be forfeited) can be used to pay expenses incurred within 2½ months after the end of the year (March 15 for calendar year plans) provided the flexible spending account plan document is amended by the end of the plan year to which the grace period will apply (December 31 for calendar year plans). In response to inquiries about how much an employer should report in Box 10 of the employee’s W-2 in situations where the grace period is used, the IRS, in Notice 2005-61, said the employer can report the amount contributed by the employee for the year unless the employer knows, at the time the form is prepared, the actual amount reimbursed for the year to which the Form W-2 relates. IRS Notice 2005-61.

CASES

Failure to Furnish SPD Leads to Additional Benefits. In Rothwell v. Chenango County N.Y.S.A.R.C. Pension Plan (NDNY 2005), the defendant, Chenango County Chapter of the New York State Association for Retarded Citizens (ARC), maintained a defined contribution plan under which participant accounts were valued once per year, as of December 31. The plaintiff, Beverly Rothwell, was an ARC employee and long-time participant in the plan. Under the plan’s distribution policy, the amount of a terminating participant’s lump sum distribution was dependent upon the date the participant’s employment ended: If on or before September 30, the participant would receive the value of his or her account as of the preceding valuation date (December 31 of the prior year); if after September 30, payment would be made based on the participant’s account value as of the following valuation date. Apparently, this policy was not widely known and ARC had never distributed an SPD explaining it. Rothwell ended her employment with ARC in October 2001. Before she resigned, the executive director, who served as plan administrator, mistakenly told her that she was lucky because her pension account would be valued as of the preceding December 31, and she would not suffer the market losses that had occurred in 2001. Instead, in accordance with its distribution policy, the plan paid her the value of her account as of the next valuation date (December 31, 2001), resulting in a distribution of $20,000 less. An unhappy Rothwell then sued the plan for the additional money and won. In awarding the additional money plus interest, the federal district court held ARC had breached its duty by failing to give Rothwell an SPD explaining the plan’s distribution policy and that Rothwell had likely suffered prejudice as a result of the breach. Had she been furnished a compliant SPD, the court found, she could have resigned in September (instead of October) so as to qualify for the “look-back” distribution, or delayed her termination so as to qualify for the year-end 10 percent of pay employer contribution reserved for participants employed on the last day of the year. The result in Rothwell underscores the importance of maintaining (and distributing) SPDs that correctly reflect important plan terms, such as a plan’s distribution policy—and of communicating correct information to participants.

Progress on Retiree Medical Benefits and Coordination with Medicare? As you may remember, in 2000 the U.S. Court of Appeals for the Third Circuit ruled the Age Discrimination in Employment Act (ADEA) restricted an employer’s ability to reduce or eliminate retiree health benefits upon an individual becoming Medicare eligible. The decision in Erie County Retiree Association v. County of Erie (3rd Cir., 2000) was quite controversial and the Equal Employment Opportunity Commission (EEOC) proposed regulations that would permit this common plan design. The American Association for Retired Persons (AARP) sued for an injunction to prevent these regulations from becoming final. In March 2005, a federal district court in Pennsylvania, which is located within the Third Circuit, ruled the EEOC lacked the authority to issue these regulations and enjoined the EEOC from finalizing the regulations. A recent U.S. Supreme Court ruling revised the standards for determining whether a federal agency has the authority to issue certain regulations. Under the Supreme Court’s new interpretation, a court could bar an agency from interpreting the law differently only if the court has determined the only permissible meeting of the statute is contrary to the regulation. Based on this, the district court judge reconsidered her injunction order. On review, the federal district court determined that while the EEOC’s proposed regulation was not the best interpretation of the ADEA, the earlier decision of the Third Circuit did not determine the only permissible meaning of the ADEA, and, therefore, the manner in which EEOC interpreted the ADEA in the proposed regulation could not be overturned by a court. The district court judge dissolved the injunction but allowed it to remain in effect pending an appeal of her decision to the Third Circuit. While this saga is far from over, we are hopeful that eventually the EEOC will be permitted to finalize these regulations to approve what is a common employer practice. (AARP v. EEOC, E.D. PA, 2005).

Post-Retirement Spousal Waiver Ineffective. James McGowan was not ready to slip quietly into his senior years when he retired from New Jersey Natural Gas Co. in 1996. He started his benefits from the company’s retirement plan in the form of a joint and 50 percent survivor annuity with his second wife as the joint annuitant. Three years later, James was divorced. As part of the divorce, James’ ex agreed to waive her right to the 50 percent survivor annuity and to the substitution of James’s first wife as a replacement beneficiary. There was no qualified domestic relations order (QDRO). Two years later, James remarried and went to the retirement plan to name his third wife as the beneficiary of the survivor annuity benefit. The plan rejected the change in beneficiaries, taking the position that the initial beneficiary (James’ second wife) remained entitled to the survivor annuity benefit. James sued, seeking a court order to declare his current wife as the contingent beneficiary. The dismissal of the lawsuit by the district court was upheld by the U.S. Court of Appeals for the Third Circuit. The federal appellate court found the attempted change in beneficiaries would violate ERISA’s prohibition of the assignment of benefits. Once a benefit goes into pay status, it will be difficult or impossible to change beneficiaries because the benefit amount is calculated on the form of the payment and the identity of the beneficiaries. (McGowan v. NJR Service Corp., 3d Cir. 2005).

This newsletter is a periodic publication of Hodgson Russ LLP. Its contents are intended for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. Information contained in the newsletter may be inappropriate to your particular facts or situation. Please consult an attorney for specific advice applicable to your situation. Hodgson Russ is not responsible for inadvertent errors in this publication.